Bitcoin Futures and the Need for Control

I’ve been asked by a few subscribers to further discuss the potential effect of the major exchanges starting up futures trading in Bitcoin. Last month the CME Group and the CBOE – Chicago Board of Exchange — announced they would begin trading futures contracts in Bitcoin due to popular demand.

The SEC fast-tracked approval, because, what the big banks want the big banks get. This is called ‘regulatory capture’ for short. Trading is due to begin on December 18th.

Now there are a lot of issues here but the main thing is that these are cash-settled contracts. This means that, for all intents and purposes, these are dollar-based bets on where the price of Bitcoin is going in the future.

And dollars, unlike Bitcoin, are in nearly infinite supply. I’ve heard arguments that the recent price rise in Bitcoin is partly because the CME and CBOE are building inventory. That’s pure disinformation. What inventory are they building when they are never going to settle the trades in Bitcoin?

Futures Imperfect

Futures markets are a function of coordinating supply of an asset with time. If you anticipate the future need for a few million barrels of oil and want to lock in your future liability to obtain said oil, you buy some oil futures which will deliver you that oil on by that date.

By contrast, a cash-settled contract is, in effect, no different than a CFD offered by a forex broker. A CFD is a contract for difference which are simply bets on the movement in price of something. They are divorced from the underlying asset and do not affect its supply or demand like an asset-settled futures contract is.

CFD’s are really no different than betting on a football game or who will win the election. It is a pure derivative of the underlying asset and has no relation whatsoever to the trading behavior of the asset itself.

Except, of course, that traders who are looking for any edge they can get will use that data to influence their decisions. And so, as a secondary or tertiary effect, the structure of CFD markets have an effect on the market of the underlying asset.

In short, the tail wags the dog.

The question on everyone’s mind is, how much of an effect this will be.

The analogue for stocks is the VIX — the volatility index. The VIX is its own market which itself is a prime indicator of where the market is headed. The VIX is manipulated all day every day in the equity markets to support whatever narrative the political class, Wall St. and the central banks want us to believe.

The VIX used to be a small market. But, in today’s yield-starved, central-bank-coordinated world, where price discovery is suppressed in the name of market ‘stability,’ the VIX now IS the equity market.

And this is the mechanism by which a cash-settled futures market can be used to gain control over the price of Bitcoin. It will bring absolutely zero liquidity to the Bitcoin environment natively.

It will simply make high-frequency scam-trading and spoofing in Bitcoin an official part of the market through the creation of a near-infinite supply of dollars. And the issuers of that supply will use those price moves to push or pull the Bitcoin market itself to fit the needs of the banks and exchanges whose business is most threatened by Bitcoin’s existence.

The Blockchain Threat

When you look around the blockchain space you can very easily see that there are a number of projects attempting to marginalize the existing financial trading infrastructure.

They are building blockchain analogues which require no third party to settle and clear trades or provide liquidity pools. From cross-chain atomic swaps to distributed exchanges with direct fiat conversion, the cryptocurrency community is becoming focused on replacing the current system with one less subject to manipulation through central bank largess.

The central banks themselves know they are under attack at an existential level. And it is why the major ones will never truly embrace digital assets in any substantive way.

Bitcoin is a digital analogue to gold with respect to the Federal Reserve. So, the Fed, which props up confidence in the dollar by marginalizing gold, will never create a Bitcoin-derivative. Doing that would state categorically it doesn’t have faith in its own currency. Why create a crypto-dollar when the real dollar (itself just as much a digital asset as Bitcoin) works just fine.

We have historical precedence for this with gold. And I remember the crowing in the gold community when the SPDR Gold ETF (NYSE:GLD) was formed. All the same liquidity and ‘bringing the big boys in’ arguments were made and yet, buried deep in the prospectus was the poison pill about how the ETF dealt with settlement and what assets it actually held — futures contracts, not gold.

And is it any surprise that with the rise of GLD the leverage on the gold futures platforms around the world has risen to astronomical levels?

So, don’t think for a minute that the CME or the CBOE are implementing Bitcoin futures for our benefit or simply because they want a cut of the action. No, they are doing so because they see the existential threat to their business and are moving to defend it by becoming part of the action.

The Way Forward

But, there is a silver lining to this. Bitcoin is not an asset where the existing power structure can coordinate pricing worldwide 24/7. And Bitcoin trades, much to the consternation of everyone in power, 24/7.

Gold is easily manipulated (up and down) because like all other assets trading on official exchanges, gold closes on Friday afternoon and doesn’t start up again until Sunday afternoon. That’s two days of policy coordination talks, headlines, bad-bank settlements and the rest to ensure that it, like any other systemically-important asset, does not spasm in price and cost anyone important too much money.

Blockchains operate all day, everyday. And there truly is no reason why they should ever stop trading. So, the future exchanges, if they are planning on trying to control the Bitcoin price through their derivatives, better be subtle about it.

Because what they bring to the table first and foremost is their imprimatur of professionalism. These are supposed to be the most trusted, most sophisticated market making platforms in the world.

And their entry into this space is supposed to professionalize the way Bitcoin is traded and price discovery achieved. And without 24/7 exchange coverage they better behave themselves or the market will lose confidence in the product very quickly as arbitrage effects will destroy their credibility.

Because, remember, once the blockchain-equivalent platforms are up and stable there will be a whole new level of trust added to the financial system. There is absolutely zero reason why a blockchain based, coin-settled futures market can’t compete with the CME Group or the CBOE.

At which point we enter into a whole different regime of price discovery.

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